Below is the fifth of nine serialized essays examining current debates over technology, standards and standard-essential patents (SEPs) aimed at educating readers about an area of law and economics that is increasingly in the news. This essay has been adapted from a speech Mr. Kappos, former director of the U.S. Patent and Trademark Office and U.S. Undersecretary of Commerce, delivered in Taiwan in March at the International Symposium on Standards, SEPs and Competition Laws

David J. Kappos, former director of the USPTOdkappos@cravath.com

One of the worst legal acronyms, the SSPPU, or Smallest Salable Patent Practicing Unit, is the smallest component that practices a given patent within a larger multi-component device. Mythtellers contend that the SSPPU provides the definitive measure for determining patent license royalty bases in all cases and contexts. These mythtellers are invariably implementers who would prefer to pay low or no royalties for the technologies that others have labored to create.

roponents of this myth have taken an evidentiary rule created for the specific context of jury trials and attempted to extend it to all patent infringement damage determinations, including in the SEP licensing context. In doing so, they are attempting to free ride on the toil of others.

Court-determined infringement damages are intended to approximate the royalty that would have been agreed to have the parties negotiated in good faith, prior to the infringement. In reality, licenses are typically issued on entire patent portfolios, with royalties calculated based on whole devices, because various patents read on various parts of those devices, leading to efficiency and simple practicality in the approach.

It would be impossible for negotiating parties to map every patent in a portfolio to a single SSPPU. Large portfolios typically include hundreds or thousands of patents covering multiple device components, with many patents spanning multiple components, including SEPs practiced by multiple standards.

Furthermore, the end result of the laborious process of measuring the value that thousands of individual patents convey to each device in which they are installed would ultimately be an exercise of aggregating each sub-royalty to determine a portfolio-level royalty scheme. This is precisely the exercise performed today without the unnecessary futility. Device-level portfolio licensing is used because it is a fair and efficient way for licensees to obtain freedom to operate while allowing licensors and licensees both to enjoy ease of administration. However, the SSPPU myth holds that genuine market evidence should be set aside in favor of the legal fiction of the SSPPU and its counterfactual system of correlating specific components to particular patents.

Since real world negotiations are based on complete products and not SSPPUs, courts attempting to approximate real world negotiated licenses must focus on whole devices and entire portfolios—not SSPPUs.

The truth is that Judge Randall Rader developed the SSPPU concept in 2009 to navigate a specific one-off circumstance. Patent holder Cornell University sought to present an entire Hewlett-Packard computing system as the relevant royalty base in their infringement litigation, even though their patent was only practiced by a subcomponent. The patent in the case increased the speed and efficiency of the instruction reorder buffer of Hewlett-Packard’s processors. The processors could either be sold on their own or installed in CPU modules, which could either be sold or installed in CPU bricks, which could then either be sold or installed in servers. Properly recognizing that this single patent circumstance fell outside of sensible parameters for damages computations, Judge
Rader prevented Cornell from attempting to mislead the jury by presenting large and inapposite server sales revenues.

In the Cornell case, the more efficient processors may have increased the market value of Hewlett-Packard’s servers, but they were plainly only responsible for a subset of each server’s value. Judge Rader thus invented the SSPPU theory to deal with this specific context: a jury dealing with a single patent, the patented feature within a modular product used in a nested series of increasingly larger products, each having a discrete market value. The SSPPU rule is that in this particular circumstance, juries should be instructed that sales of the first-order product provide the proper royalty base.

The artificial extension of this theory is not only unworkable, but also economically unsound. Demonstrating this myth’s falsity, many courts have attempted to use the SSPPU rule to apportion damages for an accused multi-component product that is itself the SSPPU. This occurs whenever the applicable subcomponent is not offered by itself in the relevant market, making the entire product the smallest salable unit. The SSPPU theory is plainly illogical in this circumstance because a product typically possesses many features that are not related to the litigated patent. An iPad camera’s autofocus feature provides an example. The iPad itself is the SSPPU, turning the theory in on itself.

SSPPU theory also ignores the value of synergies and downstream complementary effects that are created by pairing the patented technology with the other components of the final product. The chips that allow tablets and laptops to utilize the IEEE 802.11 Wi-Fi standard cost only a few dollars, but the value that access to the Wi- Fi technology standard contributes to these final products is quite substantial. It is absurd to contend the value of a laptop with wireless Internet access only exceeds the value of a laptop without Wi-Fi by the few dollars manufacturers charge for Wi-Fi chips.

The value of the patents implemented by the Wi-Fi standard cannot be measured in isolation. Value is contextual. The true economic value of an SEP is the amount the patented technology increases the usefulness of the end product in which it is included. The true value of a Wi-Fi chip is a product of its interaction with and usage by any additional technology with which it is paired, as well as the network effects triggered as the technology standard proliferates. Newer tablets continually boast larger, higher resolution screens and faster processors, requiring faster wireless data transmission speeds to enjoy the benefits of new browsing, gaming and video watching capabilities.
Accordingly, the value of Wi-Fi connectivity within tablets increases with each wave of new devices. With each additional feature, Wi-Fi delivers additional consumer value.

The iPhone provides a similar example of added value: at the beginning of 2014, an unlocked 32GB iPhone 5C sold for $649, while a 32GB iPod Touch retailed for $249 in the United States. These devices were nearly identical except for the phone’s cellular connectivity—namely, 3G LTE—which added $400 to the device’s market-recognized consumer value.

The flawed SSPPU theory would grossly underestimate this $400 value by erroneously focusing on the cost of the wireless chip prior to installation, rather than its value inside an iPhone, which is a function of the consumer value derived from always-on, omnipresent connectivity. Fairness dictates that device manufacturers pay a higher royalty for the use of SEPs in higher-value products, which derive more value from the use of the technology standards. Thus, SSPPU valuation robs the future of innovative potential by undercompensating patentees.

It is clear that the SSPPU myth is nothing more than an attempt by implementers to obtain technology developed by the innovative efforts of others at improperly low royalty rates, below the rates that would be obtained through legitimate licensing arrangements. Accepting this myth leads to a perverse innovation policy that rewards misappropriation and encourages licensing holdout, while reducing innovation incentives.

As the U.S. Court of Appeals for the Federal Circuit ruled in the recent CSIRO v. Cisco case, the SSPPU is absolutely not the king of patent royalty damages.60 The truth is that applying the SSPPU theory beyond its original purpose imprudently tips the critical balance of interests between implementers and inventors, encouraging free riding and discouraging innovation.